Tax Time for Sole Proprietors: More in Your Pocket than Uncle Sam’s by Saving

Monday, April 15, is almost here: the day Uncle Sam makes his reckoning. Are you ready?

You’ve worked hard all year as the sole proprietor of a business with no employees. All that hard work has paid off, and business is flourishing. As a result, you have brought in more income than last year.

First of all, congratulations on a great year! Take a moment to reflect on how far you’ve come. As the sole proprietor of a business, the buck literally stops with you. Be proud of your financial success; you made it happen!

After saying, “Thank you!” to all this praise, you might be thinking, “But doesn’t more income also mean more taxes? How much will Uncle Sam take from my hard-earned dollars? Is there a way to keep more dollars in my pocket?”

First, you might consider a couple of traditional options for last year:

  1. Tax deduct $5,500 ($6,500 for age 50 and older) by saving the maximum amount to your IRA
  2. Tax deduct up to 25% of your income by contributing to your SEP IRA. SEP stands for “Simplified Employee Pension,” a traditional IRA for self-employed individuals or small business owners. Any business owner or anyone with freelance income can open a SEP IRA.

Now, if you are pretty sure that you will be earning the same income this coming year…

Consider a Solo-401(k) or a one-participant 401(k). How does it work? You can save $19,000 (under age 50) or $25,000 (age 50 and older) as employee. The employer contribution portion in this plan is powerful — you can shelter an additional 25% of your income in it.

As a sole proprietor with no employees, you are both the employee and the employer!

The total contribution limit to a participant’s account, counting catch-up contributions for age 50 and older in 2019 is $61,000. For under age 50, your limit is $56,000.

For example: Mary, the sole proprietor at age 51, earned $100,000 in W-2 wages from her S Corporation in 2019. She defers $19,000 in regular elective deferrals plus $6,000 in catch-up contributions to the 401(k) plan. Her business contributed 25% of her compensation to the plan, $25,000. Her total contributions to the plan for 2019 were $50,000.

Bottom line: Mary, at age 51, can tax deduct a total of $50,000. Imagine how much tax Mary could save! If her Federal Marginal bracket is 24%, she would have saved $12,200. In other words, it takes after-tax $37,800 to have $50,000 in her Solo-K account.

Taxes still must be paid when the funds are withdrawn or distributed. There’s no way to avoid this. However, if you have a good 10, 20, or even 30 years to compound grow, these tax-deferred funds could become very significant. In addition, money we can’t access easily, we won’t spend easily.

You’ve done the difficult part already, making your business a success. Now, put those hard-earned dollars to work for you. The tax-deferred funds will reduce your taxes this year and will grow while you continue to grow your business. As a sole proprietor, this tax strategy of saving more and paying Uncle Sam less will pave the path to your financial independence in the long run.

Now you are ready to face Uncle Sam with a hat trick of your own!

*For actual tax saving on your specific tax situation, please consult with your tax accountant or CPA.

* For more information, https://www.irs.gov/retirement-plans/one-participant-401k-plans

About Alice Tang

Alice Tang, ChFC® is a Financial Advisor, Speaker and Educator. As an immigrant to the United States, Alice faced the reality of starting a career from scratch, forcing herself to become self-reliant. Self- discovery became her life-calling, and she has since made a name for herself as Financial Advisor, Speaker and Mentor, led to inspire others, especially women, to be courageous, confident and successful.

“Step into your power courageously.  Your deepened relationship = Your Wealth.” – Alice Tang

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